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(^44) Financial Management
The price change over the period, is the difference between the beginning (or purchase)
price and the ending (or sales) price. This can be either positive (sales price exceeds
purchase price) or negative (purchase price exceeds sales price).
The general equation for calculating the rate of return for one year is shown below:
K = [Dt + (Pt - Pt-1)]
Pt-1
where K = Rate of Return
Pt = Price of the security at time "t" i.e. at the end of the holding period.
Pt-1 = Price of the security at time "t-1" i.e. at the beginning of the holding
period or purchase price.
Dt = Income or cash flows receivable from the security at time "t".
Valuing Debt Securities
Securities that promise to pay its investors a stated rate of interest and return the
principal amount at the maturity date are known as debt securities. The maturity period
is typically more than one year which is the key differentiating factor between them
and the money market securities. Debt securities are usually secured. Debt securities
differ according to their provisions for payment of interest and principal, assets pledged
as a security and other technical aspects. In the case of bankruptcy of the corporation,
the law requires that the debt holders should be paid off before the equity investors.
A legal agreement, called a trust deed, is drawn between the security holders and the
company issuing the debt securities. Every security issued under it has the same right
and protection. Trust deed is a complicated legal document containing restrictions on
the company, pledges made by the company, and several other details. The trustee,
usually a large bank or a financial institution, ensures that the issuing corporation keeps
its promises and obeys the restrictions of the contract. The trustee is the watchdog for
the debt securities holders because it is impossible for the individual holders to keep an
eye on the functioning of the company.
Debt securities are different from term loans provided by the financial institutions and
the banks to the company. Term loans are long term debt contracts under which a
borrower agrees to make a series of interest and principal payments on specific dates
to the lender. While this is true for debt securities also, term loans differ in one significant
aspect that they are generally sold to one (or few) lenders especially financial institutions
and banks, while debt securities (terms 'debentures' and 'bonds' will be used
interchangeably for debt securities) are typically offered to the public. Another significant
difference is that principal repayments in term loans are made along with the interest